United States Gypsum Company v. United States, 18357-18362.

• Decision Date: 28 January 1972
• Docket Number: No. 18357-18362.,18357-18362.
• Citation: 452 F.2d 445
• Parties: UNITED STATES GYPSUM COMPANY, Plaintiff-Appellee and Cross-Appellant, v. UNITED STATES of America, Defendant-Appellant and Cross-Appellee (two cases). UNITED STATES GYPSUM EXPORT COMPANY, Plaintiff-Appellee and Cross-Appellant, v. UNITED STATES of America, Defendant-Appellee and Cross-Appellant.
• Court: U.S. Court of Appeals — Seventh Circuit

452 F.2d 445 (1971)

UNITED STATES GYPSUM COMPANY, Plaintiff-Appellee and Cross-Appellant, v. UNITED STATES of America, Defendant-Appellant and Cross-Appellee (two cases).

UNITED STATES GYPSUM EXPORT COMPANY, Plaintiff-Appellee and Cross-Appellant, v. UNITED STATES of America, Defendant-Appellee and Cross-Appellant.

Nos. 18357-18362.

United States Court of Appeals, Seventh Circuit.

October 29, 1971.

Rehearing Denied January 28, 1972.

Charles M. Price, William D. Mc-Farland, Robert M. Gunn, Chicago, Ill., for U. S. Gypsum Co.; Price, Cushman, Keck & Mahin, Chicago, Ill., of counsel.

William J. Bauer, U. S. Atty., Chicago, Ill., Johnnie M. Walters, Asst. Atty. Gen., Tax Div., Thomas L. Stapleton, Atty., Dept. of Justice, Washington, D. C., Lee A. Jackson, Acting Asst. Atty. Gen., Meyer Rothwacks, Gilbert E. Andrews, David English Carmack, Joseph M. Howard, Attys., Tax Div., Dept. of Justice, Washington, D. C., for the United States; James R. Thompson, U. S. Atty., of counsel.

Before HASTINGS, Senior Circuit Judge, FAIRCHILD and KERNER, Circuit Judges.

FAIRCHILD, Circuit Judge.

United States Gypsum Company (USG) and United States Gypsum Export Company (Export), a wholly owned subsidiary of USG, brought actions for refund of income taxes. Some of taxpayers' claims were established. The only issues before us on appeal relate to offsets claimed by the government on account of reallocations of income under 26 U.S.C. § 482 between USG and Export and between USG and another subsidiary, Panama Gypsum Company, Inc. (PG). The decision of the district court is reported at 304 F.Supp. 627 (N.D.Ill., 1969), and we shall avoid unnecessary repetition.

The Shipping Issue.

PG provided shipping service to USG, its parent corporation, during a number of years, including 1954, 1955, 1957 and 1958, the years in question. The government claims that the compensation paid by USG to PG was excessive. 26 U.S.C. § 482, in part, authorizes the Secretary or his delegate to allocate gross income, deductions, etc., between a parent and subsidiary if he determines that such allocation is necessary in order clearly to reflect their respective incomes.

As stated in the government's brief: "If, upon examination, it is determined that the dealings between the corporations under common control do not approximate what would have taken place between uncontrolled corporations dealing at arm's length, a reallocation of income is required under Section 482 to clearly reflect the income of the separate taxable entities involved."

The district court found "that the rates set, though they may have been relatively high and were not actually negotiated at arm's length but arbitrarily set, were reasonably within the range of what would have been charged for similar services in an independent transaction between unrelated parties under similar circumstances. Even with its well informed hindsight, the government has presented no persuasive evidence that the rates were unreasonable." The court found that the resulting income should not be reallocated. (p. 635)

PG and USG entered into long term contracts of affreightment, under which PG charged USG a freight rate per ton for carriage of gypsum rock from ports near the sources to ports serving USG's plants. The rate was computed by taking the cost of time chartering a ship, of a type suitable for the purpose and then available on the market for charter, adding expenses which a charterer on a time-charter basis would have to bear (fuel, port charges, and administrative burden), dividing this total cost of a round trip by the number of tons the prototype ship could carry, and adding 25 cents per ton for unloading (15 cents per ton beginning in 1955).

The ships actually used were larger and faster than the prototype and the expenses of operation lower. They were specially built so as to meet certain problems peculiar to the port at the Canadian source of supply, and, except for the King, carried equipment which, when used with equipment at the ports of destination, made the ships self-unloading. No closely comparable ships were available. The agreed rate per ton was not adjusted to reflect the greater efficiency of the specially built ships, and unless some other adverse factor were to operate, the rate would be very advantageous to PG. On the other hand PG was exposed to the risk that USG would not need enough rock to keep the ships busy and that loss would result from idleness if alternative uses could not be found.

It turned out in fact that the ships were kept busy and PG enjoyed a high profit at the per ton rates under these contracts. The real question is whether people dealing at arm's length would have deemed the advantageous rate per ton a reasonable, though not directly related, offset for PG's assuming the risk of slack usage.

The choice of this approach was described by Mr. Rembert, Executive Vice President of USG. Mr. Bardelmaier, the expert called by USG, testified that the Rembert approach was fair and reasonable, although he considered the 25 cents per ton for unloading unrealistically low, and therefore favorable to USG as shipper. He made comparisons of the agreed rate with rates constructed on other bases, including the rates he thought he would have charged if he had been an independent ship owner offering to perform the same service. In each comparison he found the agreed rate reasonably in line or lower.

Mr. Kerwin, the government's expert, stated his opinion that a long term time charter would have been the only practical form of agreement under the circumstances. Under such a charter, USG would have assumed any risk of under-employment of the ships. Proceeding on this basis, and with knowledge of the actual use of PG's ships during the years in question, Kerwin computed USG's transportation costs (1) "based on the actual voyage expenses, plus the minimum vessel expense which an owner would have accepted" and (2) "based on the actual voyage expenses, plus the maximum amount which a shipper would have reasonably paid." He included amounts which he deemed appropriate for the owner's profit and depreciation. The results were very substantially below the amounts paid by USG to PG during the respective years.

On cross-examination, it was developed that Mr. Kerwin's figures did not represent a projection of a long term contract as of the time of contracting. "Q. * * * You have taken the costs and pulled them back into a time charter, have you not?" A. "Yes."

"Q. You didn't do like Mr. Bardelmaier did and put himself in our place in 1947 and again in 1954 and try to project rates for a long-term contract? You did not approach it that way?"

"A. This was not my approach."

Thus Mr. Kerwin's analysis was open to the interpretation that it was, in effect, a retroactive renegotiation of the agreement for the purpose of limiting the ship owner to a reasonable profit rather than a reconstruction of bargaining over an agreement to cover future conduct.

We might well speculate that if parties under similar circumstances had been dealing at arm's length, and had acquired the experience from 1948 to 1954, they might, by 1954 and later years, have worked out a deal which would have cost the shipper less and returned to the ship owner a lower, yet still reasonable, profit. Nevertheless, we are unable to say, on this record, that the finding of the district court that the shipping charges were those which would have been arrived at by dealings at arm's length was clearly erroneous.

Whether the district court addressed itself to precisely the proper issue is not free from doubt. The problem arises because the district court was, in effect, reviewing an ex parte administrative decision to allocate, and many decisions refer to the power to allocate as discretionary, stating that an allocation between taxable entities under common control is to be upheld in court unless the court finds the allocation is unreasonable, arbitrary, or capricious.¹

We note that the Treasury Regulations, 26 CFR § 1.482 have recognized close restrictions upon the breadth of discretion which might reasonably have been read into the statute. Under those provisions the key question is whether the terms of transactions under consideration are such as would have been arrived at in independent transactions with or between unrelated parties under similar circumstances, considering all relevant facts. This key question is factual in nature, and such nature tends to narrow any difference between an issue whether a price was equivalent to an arm's length price and an issue whether an administrator's ex parte decision that it was not an arm's length price is unreasonable, arbitrary, or capricious.

Our recent decision in Baldwin-Lima-Hamilton² implies that the question of what terms would have been arrived at in arm's length dealing is a question of fact to be resolved by the court, for when it appeared that some allocation was appropriate, but the allocation made by the Commissioner was erroneous, we remanded the case with instructions that the court determine the proper allocation.

Bearing in mind that the district court expressly found the government's evidence unpersuasive, and that the government has not really addressed argument to the distinction above suggested, we treat the district court's finding as equivalent to a finding that the administrative decision that the charges were not arm's length charges was unreasonable, arbitrary, and capricious, and deem the finding not clearly erroneous.

The issue as to USG's payments to PG for...